How Critical Is the Housing Market?

How Critical Is the Housing Market?

Article excerpt

TO SOME, THE SLOWDOWN IN the housing market is the catalyst for a major economic downturn. Decreased construction activity, the loss of housing wealth, and the resetting of adjustable rate mortgages all suggest a decline. Yet, it's really a question of magnitude and whether there will be offsetting effects.

Over the last 46 years, residential fixed investment (i.e., new construction plus improvements) accounted for only about 4% of overall GDP growth. However, over the last three years, residential fixed investment accounted for over 13% of GDP growth. Still, a moderate retreat in residential construction would subtract only a few percentage points from growth--from 3.5%, to say, 2.7% (all else equal).

Why, then, is there such an emphasis on residential construction? For one, it is a leading economic indicator. However, as with the dampening in business inventories, we are no longer likely to see large cyclical swings in residential construction activity.

Some of the housing market strength of the last few years has been due to a rebound from the stock market boom. During the late 1990s, with the stock market rising sharply, housing was an unattractive investment. After the stock market bubble burst, housing looked like a much more reasonable alternative to pouring money back into equities. In addition, tax cuts fanned the demand for second homes.

Housing debt has risen sharply in the last few years, but the increase has been dwarfed by the gain in home equity. …